Saturday, 28 May 2011

The details of the EU/IMF-Portugal financial aid agreement (see draft Memorandum of Understanding on Specific Economic Policy Conditionality or MoU – available here) that were first made public seemed to suggest that the EC/ECB/IMF troika that negotiated it had finessed its strategy ever so slightly, and had learnt from the experiences of Greece and Ireland.

Instead, the agreement with Portugal, as laid out in the draft MoU, is overwhelming in scope. The implied message from the troika seems to be that the approach is failing in Greece and Ireland because it did not go far enough.

The agreement has important measures and impresses by its breadth. However, it also suggests that the troika may not have had the time to check their facts on issues such as, for example, external trade or on housing prices. Data collected by Carmen Reinhart and Kenneth Rogoff in a 2008 paper suggests that Portugal had one of the lowest housing price increases between 2002 and 2006 amongst 43 developed and developing countries. Therefore, one wonders why the troika imposed measures that make house buying more expensive at this stage of the cycle where numerous families are being forced to sell their homes either to avoid foreclosure or due to foreclosure on their mortgages.

More importantly, the agreement has serious issues of process and substance, of which four should be emphasized:

First, there is no discussion of the causes of this crisis, what led Portugal to this situation. It is like going to a doctor seriously ill, and coming back with no diagnosis of the illness but instead with 222 different prescriptions (the number of main action items in the MoU which runs to 34 pages, or roughly twice the length of action items in Greece and Ireland’s MoUs), hoping that some of the medicaments will work. They won’t. The patient’s health will worsen. Portugal faces a balance of payments and external debt crisis, rather than simply a sovereign debt crisis. Perhaps because the MoU does not identify the causes of the crisis, the policy response measures are misguided and likely to fail.

Moreover, given the sheer number of measures, there is no way that a future government, regardless of the party in power, will be able to fully meet the terms of the agreement. The government will likely miss several targets fairly early in the program and this will call its competence into question with its European Union partners, unnecessarily, but perhaps by design.

Second, the agreement does not ask nor respond to the question of who was responsible for what went wrong. One might argue it is neither possible nor relevant at this stage to do so. Quite in contrary, it is important to identify who erred because market economies are all about risk, reward, and punishment. It is also possible to find them. We just have to look for the proverbial elephant in the room.

Who are the largest debtors now unable to pay? Answer: in Portugal’s case, the government and the banks. So, they must have made mistakes. In this, the picture that emerges is similar to that found in Greece and in Ireland.

Who are the largest creditors now afraid of not getting their money back? Answer: large banks and insurers in a number of countries and the Eurosystem (ECB and Eurozone national central banks). In fact, the Eurosystem is the largest creditor of Portugal as well as of Greece and of Ireland’s banking systems and governments. So these creditors also made mistakes.

The consequences of the mistakes should be borne by those who made them. But it is not to be. Instead, the costs of the bailout are to be exclusively assumed by the Portuguese taxpayers and citizens. This is not the culture of merit and accountability the European Union deserves.

Third, the agreement focuses on the minutiae, on far too many wishful thinking ideas in a cross-section of areas from financial sector regulation and support, judicial system organization, to local and regional administration, to name a few. The large number of measures precludes any serious attempt to evaluate their individual effectiveness. Instead, the MoU should select the 20% of ideas with 80% of the economic impact (each with an economic impact above, say, €250 million per year) and thoroughly dissect each of them. Otherwise, it is simply obfuscation.

Finally, the policy measure with the largest economic impact is not correctly implemented. Specifically, in dealing with the Portuguese banks, whose combined liabilities represent 250% of GDP, the agreement does not adopt international best practice. This would have required, before any capital increase or guarantee, the introduction of a special bank resolution procedure (Special Resolution Regime with Prompt Corrective Action), like those available in the US and in the UK, for example. A strong and prompt bank resolution procedure would, among other things, impose losses on the creditors of failing banks and would force out failing banks’ management. Instead, the troika required the Portuguese taxpayer to further support the banking system with up to €47 billion (27.2% of GDP) between guarantees and capital increases.

Moreover, rather than replace failing banks' management, following, for example, the practice of the US FDIC, the MoU (p.7) states that the capital increases “will be designed in way that preserves the control of the management of the banks by their non-state owners”. That is, the taxpayer will likely recapitalize the private banking system, in effect nationalizing it, and yet management control will remain with the old owners. One possible explanation for the troika’s inaction on the banks Special Resolution Regime is the conflicts of interest faced by one of the troika members, the ECB. The ECB is a member of the Eurosystem, which would have faced large losses if a proper bank resolution procedure were adopted immediately.

The idea substantiated in the MoU that an entire country can be reengineered - notwithstanding its faults, the World’s 38th biggest economy - based on a 3-week 34-page outline is remarkable. The agreement seeks to reinvent the wheel and in the meantime destroy what does work. This treatment of Iceland, Hungary, Latvia, Greece, Ireland, and Portugal is beginning to seem like the West’s version of China’s Great Leap Forward: impossible targets based on but pure ideology. It is simply too sad to watch.

Wednesday, 18 May 2011

The current discussion about "Novas oportunidades", a multi-million-euro public program introduced in 2006 to certify skills and improve schooling levels, highlights the dearth of evidence about its effects, especially in the labour market.

So let me present some preliminary results from my ongoing research on this issue, based on data from "Quadros de Pessoal". The sample used is based on over one million workers with between four and 12 years of schooling that are working in the same firms in both 2006 and 2009. I then focused on those who increased their schooling levels between those two years and compared their wage growth over that period with the wage growth of other workers whose schooling levels did not change.

The estimates are, of course, just a first approximation and are subject to a number of caveats, which will bias the results in different directions. For instance, some of the workers whose schooling levels increased may have obtained their higher degree from a standard school, not NO. Some of the changes in schooling may be driven by measurement error, not NO. And the wage growth of people whose schooling levels do not change may not provide a good counterfactual. However, as far as I know, there are no studies about the labour-market effects of NO and very little data available. In this context, these estimates will hopefully be of some interest.

What do the results indicate? First, that average nominal wage growth over the period for the entire sample was about 12%; and that about 5% of those workers increased their schooling levels, mostly from 6 to 9 or from 9 to 12 years of schooling.

Second, and more importantly, the wage growth of those workers that increased their schooling degrees (presumably in many cases because of NO) was, on average, about 0.6 percentage points higher than those that had the same schooling in 2009 and in 2006. Dividing by the number of additional years of schooling (i.e. on a per year of schooling basis), the effect of NO is around 0.2 percentage points. This compares with a 0.4 percentage increase in wage growth for each extra year of schooling across the full sample.

My take on these preliminary results is that the labour-market effects of NO appear to be weak. Perhaps this is not surprising - if the program is essentially about certifying skills that people already have, then presumably those skills are already rewarded by the labour market. In other words, it matters much more what people can do than the diplomas that they have. If the program is to be adjusted in the future, it would probably be good to strengthen the skills dimension to the detriment of the certification element. Releasing data for researchers would also be nice.

Monday, 16 May 2011

The cut in employer payroll taxes (TSU) is perhaps one of the few memorandum items that can be seen as expansionary. However, this policy created great controversy in Portugal, in part because it will have to be funded from higher VAT rates, in part because the party supporting the current government appears to be unsure about its original pledge on this matter.

In any case, the motivation for this "fiscal devaluation" is clear - wages are high, compared to productivity, and this contributed to the huge imbalances of the Portuguese economy. According to some authors, wages need to fall by around 20% before the country can restore its lost competitiveness. Without any action, the economy would correct this imbalances only over a slow and painful adjustment process involving very high unemployment rates: Extrapolating from studies that find that real entry wages tend to be about two percent higher when the unemployment rate is one percentage point lower, the unemployment rate would have to increase by at least ten percentage points, to a Spanish-sounding level of 21%.

Cutting payroll taxes could make the adjustment process less hurtful, as it would reduce the wages paid by employers without damaging the incomes of workers. According to the estimates above, cutting TSU by four percentage points (from their current level of 23.75%) would reduce the increase in the unemployment rate by two percentage points. The remaining competitiveness gap could then be closed by the other items in the memorandum - public sector cuts and higher productivity stemming from structural reforms -, without further increases in the unemployment rate beyond the already unprecedented 13% predicted for 2013.

In my view, the main issue with this idea is actually whether firms would be able to ensure that the cuts in the payroll tax would not be passed on to their employees. Previous evidence from somewhat similar reforms in Chile and Finland suggests that wage moderation in this context can be weak. Several results also indicate that "rent sharing" is an important phenomenon in Portugal (as in many other countries): Employees - in particular those with more tenure - tend to be able to extract a considerable share of any windfalls in profits in the form of higher wages.

For the TSU cuts to be successful, they should be directed towards industries where labour demand is more sensitive to the wage rate. Many of them will be industries which are exposed to international trade but not necessarily low-wage industries. A national agreement about wage moderation involving the main unions would also be important, as well as cuts in labour adjustment costs (some of which are also in the memorandum even if perhaps somewhat timid).

Saturday, 14 May 2011

I have been away from the blog for the past week. After reading the discussion here early today, I think I have to explain why the interest rates in the Portuguese rescue package are not at all mysterious. Actually, there isn't even much genuine news around them.

This is hard and very nerdy, but here's my attempt at a short explanation:

1. The IMF interest rate follows a strict rule. There is no discretion involved. Anyone with a calculator could see it was going to be 3.25% for the first three years and 4.25% after, as soon as the size of the loan was announced.

2. The ESFS and the ESM have announced they follow the same rule as the IMF. They used to charge a bigger risk premium, but now the discussion is only whether they should charge an extra premium between 0 or 0.50%. That was the only thing under debate, and the only relevant news. So again anyone with a calculator could have figured out that the ESFS rate would be between 5.5% and 6%.

3. Why then 3.25% in the IMF loan and 5.5% in the EU loan? Because the first depends on the IMF's cost of funds (the SDR rate) whereas the second depends on the EU's cost of funds. The first is 0.52% right now, and the second is about 2,8% right now (it was 2,89% in January). So , here is (approximately) your 2,25% gap.

4. Why are the costs of funds so different? The main reason is that the IMF rate is variable, the ESFS rate is fixed. Or, to be more concrete: go to the bank to get a mortgage and they will offer you a rate if you want a variable loan (LIBOR + "Spread"), and a different rate if you want a fixed-rate loan. The difference between the two can be pretty high, but the bank is (roughly) offering you the same deal in expected value. I'd have to go super-nerdy to explain why. (A second reason for the gap is the exchange rate risk: the IMF lends in a different currency than euros, but I think the more important is the fixed-variable difference.)

5. What is the relevant interest rate for debt sustainability calculations over the next 7 years? That is tricky. If you believe the market prices for the swap contracts associated with the differences in point 4, then the answer is that 5.5% is the right number.

6. To sum up, the IMF rate and the ESFS rates are different things, apples and oranges. Converting the two loans into the same thing, you get that (approximately) 3,25%=5,5%.

Update: This is a hard and specialized topic, and my guess is that most economists would likely be confused about it. So there is no shame in getting it wrong. A tribute to Rui Peres Jorge, a journalist for Jornal de Negocios, and one of the best economics reporters in Portugal for explaining it well.

Update 2 (Sunday, 5/15): I have edited my previous update to remove references to some articles that were confusing about these calculations. Some people seem to have interpreted those links as some kind of criticism, which could not be farther from my intention. I was only trying to illustrate that this is a really technical and specific (nerdy) topic, so even good economists could get confused about it. My guess is that the majority of even my distinguished colleagues at Columbia wouldn't have known how these interest rates are set. Also, I completely agree that the interest rate charged is too high and that we may be able to negotiate it down. I know it is election campaign time in Portugal, and people are getting into smear campaigns, personal attacks and ego clashes but, please, don't drag me into it.

Finally, Diario Economico asked me to publish a longer article (simpler and in Portuguese) explaining these interest rates: it will come out in tomorrow's (Monday) edition.

Friday, 13 May 2011

The first feeling, after disclosure of the Memorandum of Understanding, among Portuguese politicians was one of relief - it was not as tough as some feared.

The second feeling is now denial - after all, it seems to be building up among Portuguese politicians, the MoU is just a starting point, it can and should be adjusted... (?)

This is a dangerous path, and should not be pursued. We need to stick to spirit and letter of the MoU, not because it is sacred, but because our credibility is at stake here, otherwise we will be rewriting a book by Gabriel Garcia Marquez. The title will be, of course, Chronicle of a Death Foretold.

This raises a couple of issues - since the IMF intereste rate is 3.25%, the 2.25 (at least) mean exactly what?

- default risk ? but the default risk is probably larger the larger the interest rate set, it is also dangerously close to the value that will make the plan work or not - see the previous post by Francesco Franco in this blog.

- market power ? another origin of a high interest rate would be exercise of market power - take advantage of the weak bargaining position and lets extract rents. It seems doubtful that this is an issue in this case.

- punishment phase ? make an example out of this small country to avoid larger ones getting into the same troubles. Seems the more plausible explanation to me. But then it should be clearly stated, to avoid misinterpretations about the risk of the bailout plan.

Monday, 9 May 2011

The macroeconomic framework of the Memorandum of Economic and Financial Policies (MEFP) is sound. It integrates the necessary structural reforms in a model that takes into account the effect of aggregate activity on the economy. This approach makes the underlying macroeconomic scenario realistic. (In the current environment where interest rates are set by the package and monetary policy is exogenous, the potentially expansionary channels of a fiscal consolidation are absent). The fundamental objectives of the policies described in the MEFP are to rebalance the economy and to increase its potential growth rate. The essential targets to achieve these objectives are an improvement of external competitiveness, an implementable fiscal consolidation and measures to insure a stable financial system. The external rebalancing is the most pressing and challenging target. The structural policies to achieve the external rebalancing aim to increase productivity and attractiveness of the tradable sector by liberalizing labor markets and increase competition in the nontradable sector. The short run policy to accelerate and sustain the external rebalancing is a fiscal devaluation: a budget neutral tax swap between VAT and the social security tax paid by the employers. The decrease in the TSU must be passed through lower prices to increase competitiveness and improve exports. The increase in the VAT will favor saving and decrease imports. The fiscal consolidation is based for two thirds in a decrease in expenditures and one third in an increase in revenues. The increase in revenue is achieved with a tax mix biased towards consumption. Therefore the revenue increase policy of the fiscal consolidation complements coherently the external rebalancing policy. Finally the plan reinforces the stability and resilience of the Portuguese banks to permit the large national deleveraging implied by the rebalancing to occur in an ordinate way.

The table shows the recent fiscal evolution together with the consolidation path implied by the MEFP.

The consolidation plan stabilizes the debt to GDP ratio and reaches the Maastricht deficit limit of three percent by 2013. The consistency of the consolidation path is conditional on the interest rate charged on the EU-EMU tranche of the loan (the ? in Table 1). The European authorities must offer an interest rate that does not jeopardize the fiscal consolidation. Furthermore, any spread above the interest rate at which the european facilities are able to finance themselves must be clearly justified. A punitive spread for accessing the bail-out facility is perfectly fine but a spread left without justification and open to interpretation is not acceptable. The frequent monitoring of the consolidation to ensure a timely and precise implementation of the fiscal measures (decrease expenditure, increase taxes) is equally crucial. Actually the plan foresees the creation of a “Portuguese Budget Office” to monitor, assist and prepare impartial reports on the budget process. A productive strategy could be to let the new “Portuguese Budget Office” participate to the continuous monitoring of the troika for the next three years.

The fiscal devaluation is a budget-neutral change of the tax structure that increases private saving and net exports that aim at substituting a nominal devaluation. The increase in the VAT (mostly from increasing lower rates) and the decrease in the employer's social security contribution tax can achieve the desired outcome in the short run if only and only if they are complemented with wage moderation and the tax decrease is passed through lower prices.

Update:

The fiscal devaluation can have significant effects on competitiveness only if the decrease in labor costs is substantial. A precise quantitative assesment will be defined in the next quarter but the lower bound is likely to be a decrease in the revenues generated by the labor tax of 3 to 4 percent of GDP coupled with an equal increase of the revenues generated by the tax on consumption. The increase in the consumption tax will be carefully calibrated to minimize any adverse effect on the weakest and poorest part of the population. Finally, a fiscal devaluation (and appreciation in a mirror case) appears to be one of the few adjustment mechanisms to external imbalances within the currency area.

Friday, 6 May 2011

The Memorandum of Understanding has several measures related to the health sector. I provide my own view on them.

The savings required are important: 550 Million euro. The proposed measures do aim more than just short-run expenditure savings. There is a concern of building mechanisms for future control of expenditures in the public sector. These mechanisms involve performance assessment and benchmark, use of competition forces in public procurement, and introduction of best-practices in transparency and information on the evolution of the National Health Service.

Several of the measures are important and deserve to be implemented, even outside the current crisis setting. They must be seen as stepping stones for the future. They are not disruptive of the National Health Service, only of its culture of opacity.

Curiously, some - but not all - of the measures were already present in the recommendations of 2006 report commissioned by the Government.

A good deal of the effort lies in time horizon for implementation, forcing both technical excellence and political determination to be present.

In a quick appraisal of the main areas:

- moderating fees - values are to be revised, should be updated according to inflation, the structure of fees should guide patients to primary care and away from emergency departments.

- pharmaceuticals - margin reduction in distribution, change in margin structure making it regressive (here I believe we should go for dispensing fee approach instead of margin as percentage of retail price), redefine the international referencing price system to the minimum of the prices in reference countries, instead of current average.

- electronic prescription and quality in prescription - this area has been little explored as a source for savings, and the steps announced are good news for improvement. It will be essential the cooperation from the medical profession, and the IT system will have to work properly (finally, I would add!!)

- Efficiency gains - without mentioning specific areas, but looks for the incentive role that transparency and clear benchmark analysis may have. Continue redefinition of supply network of the National Health Service (including closure of unnecessary or unsafe units). The major warning is about the political process of closure, to avoid unwarranted population unrest.

- planing of health expenditures and projections over 3 or 5 years ahead. This is definitely a good idea. It was used in one specific programme (continued care network). Should be expanded to the whole system.

- reduction in fiscal benefits / tax allowances - it will mean an increase in effective copayments paid by the population, as the implicit health insurance provided is reduced. The tax allowance should not be totally removed on the account of tax evasion of providers if patients lose all interest in asking for receipts for tax purposes.

- explicit planning and follow-up of medical profession dynamics (training, exit, retirement decisions). I would take the chance to do it with all health professions.

Overall, the effect of this set of measures is crucially dependent on Government commitment . There are adjustments to be made in several points, which cumulatively have to produce the aimed savings. But the proposal plan attempts to reach these savings without compromising basic values of the National Health Service. A closer scrutiny needs to be in place, to ensure progress is achieved.

Thursday, 5 May 2011

My summary of the main labour-market policies put forward by the troika:

1. Unemployment benefits: Capping unemployment benefits at 18 months and at around 1000 euros initially, plus a cut of at least 10% after six months (but not applying to those who lost jobs before the reform is introduced, while not reducing "accrued-to-date" rights of employees - more on this below); Reducing the minimum contributory period from 15 to 12 months and extending UB's to some workers under "recibos verdes";

2. Employment protection: Reducing severance to 20 days (10 of which paid by the employers' fund) per year of tenure with a cap of 12 months both for permanent and temporary jobs - to apply in full to new hires and in such a way that does not reduce "accrued-to-date" rights of current employees; Extending the grounds for dismissals for cause (e.g. when worker does not meet objectives agreed in advance for reasons of the worker's responsibility); and

3. Other aspects: Increasing flexibility in work hours (including reduction of overtime premium); Freezing the minimum wage; restricting the extension of collective agreements, strengthening works councils (to the detriment of unions); Assessing the effectiveness of current active labour market policies and designing plan for possible improvements.

The "accrued-to-date" formulation is not very clear but I think it means that a worker is always entitled to at least whatever s/he would have been entitled according to the current/old law by the time the new law is introduced. For instance, a worker with 15 years of tenure when the new law comes into force that is subject to a collective dismissal in his 16th year with the firm would be entitled to 15 months of severance - although the new law imposes a 12 month cap - given that the old/current law indicates one month of severance per year of tenure.

In this case, this approach would be a "generous" compromise between the tripartite agreement and the demands by some employers that the reduced severance levels would apply in full to all employees, not only the new employees. Also note that unemployment benefits access is widened - including to some people on "recibos verdes".

All in all, overdue policies to make the Portuguese labour market more modern and less segmented and the economy more competitive - so that the country can get out of the current utterly avoidable mess. Of course, it would be so much better to introduce some of these policies in periods of expansion - but the country was in some cases doing precisely the opposite of that in those times.

Wednesday, 4 May 2011

(The 10 capital sins: #1)Today we finally knew the “Memorandum of Understanding Of Specific Economic Policy Conditionality” produce by the troika (ECB/EC/IMF). It has some positive contributions, but as I expected it sidestepped some major “capital sins” of public finances. Let us start with Portuguese “federalism”: MAIN PROPOSALS from the troika: to reduce transfers to local and regional governments by at least 175M in 2012 and by 175M in 2012 and limit the reduction of the regional personal and corporation income tax rates to 20%, when compared with mainland tax rates. These measures do not address the structural problem of Portuguese strange “Federalism”.When Wally Oates developed his seminal work - "Fiscal Federalism" - almost 30 years ago and gave birth to 1st generation theory of fiscal federalism, he was cautious saying that his approach was economic, although he acknowledge that political issues were relevant. Two decades after, a 2nd generation theory has given more importance to political issues.Well, in the case of Portugal political issues are determinant in shaping and they are responsible for increased public expenditure. What economic theory still suggests is that countries with several tiers of government (federal or unitary states) should have the main taxes (mainly personal and corporate income taxes and VAT) shared by the upper two levels of government (federal/central and regional) or three (also including municipalities) and this should be supplemented by a set of intergovernmental grants designed in a way to somewhat partially equalize revenues (positively discriminating in favour of poor regions) and other to promote efficiency.The Portuguese model is very peculiar, and almost nonexistent in Europe. One level of government (the Regions of Azores and Madeira) have all tax revenue generated in the territories. Citizens of these regions do not contribute one cent to the national functions of the state. Additionaly, there is a generous regional finance Act that transfers funds to the regions, and also a Local Finance Act which transfers funds to regional (and mainland) Municipalities. Finally, several regional expenditures are funded directly by the State Budget (e.g. Police, Universities, etc.). Obviously all these transfers and expenditures are funded by taxes generated in mainland Portugal. A particular weird situation exists today, since the current Local Finance Act (2007) gives the municipalities the possibility to have up to 5% of the personal income tax (IRS). The government of Portugal wants this revenue to come from the regional IRS, but the governments of the regions want it to come again from the State Budget.It is clear that this peculiar model of "Portuguese Fiscal Federalism" has no economic rationality, but it has a political explanation. This article of the Constitution was introduced in 1976 after the revolution. At that time a minor threat of independence of the islands must have frightened the politicians in mainland Portugal and the norm was adopted. Over the last 30 years, there were several amendments of the Constitution, which did not change this norm. Also the laws regulating the relationships between the Republic and the Regions (Estatutos Politico Administrativos) have been revised and the tendency has been an ever increasing degree of autonomy. Again the explanation is political. Members of Parliament (MPs) elected from these regions have been pivotal to produce majorities in the national parliament, so that they usually have a big bargaining power.These issues obviously were not considered by the troika. We just have some cuts in transfers. When the storm of the fiscal unbalance will be over, expenditure will grow again, since here no structural reform is suggested.Proposal 1 : Preferably to change this norm in the Constitution and the regional finance act, in line with what are the best practices in developed countries (tax sharing arrangements) and the economic theory of fiscal federalism suggests. If this is considered not politically feasible decrease substantially (!) regional transfers. Deduct the value of expenditures that should continue to be financed through the budget (e.g. police), from the value of transfers.Proposal 2 : Suggest to Eurostat that revenues and expenditures of the regions be classified in S1312 (where state accounts are considered en federal countries). If the regions in Portugal have more taxing powers and a greater share of revenues than states in federations why should they not be considered in S1312? This would increase transparency.

The EU/ECB, which after three packages, still does not have a comprehensive approach to deal with the problem. Still no talk of institutional reforms, still no attempt to go to the heart of the debt/bank crisis in Europe. Just continuing to muddle along, waiting for the next crisis to hit.

The officials at the Ministerio das Financas and at the IMF. They worked hard, made sensible proposals, did not exactly have strong political backing, and managed to avoid the kind of crazy/inapplicable grand measures that these packages often contain.

Relative to the original Greek package, there was good progress in terms of doing sound economics.

Privatizing EDP (electricity provider), REN (electricity grid), and TAP (airline) in the next 7 months. Where is the private money going to come for these?

The usual pattern in privatizations in Portugal has been for big economic groups to borrow heavily from banks. But then how can you square these big loan with the increases in capital ratios in the banking sector?

My guess is that the IMF/EU/ECB team, aware of this, was trying to force a sell-off of these companies to foreign owners. But the political resistance to this will be tremendous. So I fear that, in the end, pressured to sell quickly, the government will sell cheap and give *very* good deals to the big Portuguese economic groups.

It will be especially important to see the kind of financial engineering tricks that they will come up with to hide implicit loans form the government to these groups.

Conditionality in these circumstances is as powerful a constraint as they get. But what kind of stable political coalition in parliament in support of what kind of government will be able to pass in the next three years the kind of legislation required in the fields of justice, health, education, housing market, local government, scrutiny and elimination of public or semi-public entities, and regulated professions? And what technical capabilities, expertise and - especially - independent agencies are there to adequately perform the kind of analysis and cost-benefit evaluations prescribed in the package? Not sure.

After the "big bad wolf" said that they could solve Portugal's problems without firing government employees or even further lowering their wages, the political ability for any party to defend these policies went to zero. One of the many reasons why signing these deals before, rather than after elections, is a bad idea

What are the effects of more generous unemployment benefits? This question is addressed in a paper by Mario Centeno and Alvaro Novo delivered last week in a labour economics conference. The paper studies a 1999 reform in Portugal, when the unemployment benefit (UB) entitlement period was increased from 15 to 18 months for people aged 30-34. However, the entitlement was left unchanged at 18 months for people aged 35-39, who are used as a counterfactual.

The figure above displays job finding rates at different unemployment durations and finds very clear spikes exactly at the time when unemployment benefits run out. Consistently with previous evidence, these results indicate that unemployment duration increases very closely with the maximum UB length. Moreover, although one could expect that more generous entitlements would allow the unemployed to look for better jobs, the paper also reports that re-employment wages do not benefit, on average, from longer UB entitlement.

(On the other hand, there is evidence that those that leave unemployment at about 15 months when the maximum entitlement was 18 have higher re-employment wages than those that leave unemployment again at about 15 months but when that was also the maximum entitlement. However, it is not clear if the best comparison would be with workers that leave unemployment at say 12 months when the maximum entitlement was 15 months.)

All in all, the decision to extend unemployment benefits in 1999 (in a period of economic expansion) seems, in my opinion, to have been misguided and wasteful. Let's just hope that, now that the troika-led reforms are about to be unveiled, the findings from the paper prove symmetric in both the business cycle and the direction of change, i.e. that any cuts in UB duration (and generosity?) during a recession will also speed up job finding.